Stock markets in for turbulence as US Federal Reserve starts taper talk; large-caps, PSUs prefered

In the current cycle global broad money supply growth, which is the primary source of liquidity infusion, has been slowing.
(Image: REUTERS)

Domestic stock market rally may witness some hiccups as the market cycle transitions to the mid-cycle phase, where returns are expected to be moderate and policy stimulus is withdrawn.  “Expect turbulence as the Fed tapers amid weak global growth. But it’s likely to be a hiccup rather than 2009 cycle-type roadblock, as better domestic and global macro environment limit dislocations,” said domestic brokerage firm Edelweiss. So far the 125% rally in Sensex and Nifty since March 2020 lows have been termed as an early-cycle wherein markets deliver outsized returns from depressed levels with PE re-rating rather than earnings accounting for the bulk of returns. However, things are now expected to change.

Recap of earlier transitions

The bull run that started in March last year has helped the stock market rally strongly and is akin to the market rallies of 2003 and 2009, according to Edelweiss. Entering the mid-cycle, both 2003 and 2009 had stark differences. 

Stock market impact: While in 2003 the transition was successful, in 2009 the same was unsuccessful. In terms of impact on stock markets, the end of 2003 rally saw the stock market drop 20%, a shot dip. Meanwhile, in 2009, the correction lasted 12 months. 

Earnings: Edelweiss highlighted that in 2003 earnings growth remained relatively strong, although there was some moderation post-Fed rate hike. On the other hand in 2009 cycle earnings and the business cycle was derailed with earnings being subdued for nearly five years and even entering contraction zone for a brief period.

The divergence in 2003 and the 2009 cycle while entering the mid-cucle phase is believed to have been owing to the timing of global stimulus withdrawal and domestic macroeconomic situations. 

Will current cycle mirror 2003 or 2009?

In the current cycle global broad money supply growth, which is the primary source of liquidity infusion, has been slowing. “Historically, this has been a relatively good harbinger of Nifty returns given India’s strong capital flow linkages,” Edelweiss said. However, the global broad money supply is a function of fiscal impulse fading as well as weak global private sector credit cycles, which could pose a challenge during the mid-term cycle transition. 

India’s outperformance to emerging market peers could also pose a risk. Higher valuations of domestic markets have historically led to 6-12 months of underperformance. Further, the timing of policy withdrawal in the current cycle is similar to the 2009 cycle. However, Edelweiss believes policymakers are more agile and the macro-environment is more conducive for leverage this time. “This, along with India’s low macro vulnerability (ala 2003), should ensure limited economic impact,” they added.

Where to invest?

At this juncture, Edelweiss recommends investors switch from laggards and mid-caps to markets leaders such as large caps. They also advise switching from consumer durables to auto stocks and from global cyclicals to domestic cyclicals and PSUs.

Largecaps stock picks 

TCS – Target price: Rs 4,176
ICICI Bank – Target price: Rs 780
HCL: Technologies – Target price: Rs 1,616
Axis Bank – Target price: Rs 870
Larsen & Toubro – Target price: Rs 1,975
Sun Pharma – Target price: Rs 950
SBI Life – Target price: Rs 1,600
Gofrej Consumer – Target price: Rs 1,135
NTPC – Target price: Rs 145
Bajaj Auto – Target price: Rs 4,483
DLF – Target price: Rs 403
ABB – Target price: Rs 1,975
HPCL – Target price: Rs 383

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